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Court judgments in relation to civil liability of CEOs: case law overview 2017-06-09

In practice there a numerous uncertainties in relation to civil liability of management bodies of companies, scope of such liability, and related matters. On 4 April 2017, considering the current situation, the Supreme Court of the Republic of Lithuania (the Supreme Court or SC) published the first overview of case law in relation to application of the norms of civil law regulating civil liability of management bodies of companies in the case law of the Supreme Court. The overview mostly analyses the matters of obligations and civil liability of sole management body of the company, the managing director (CEO) of a company. The need to formulate a single effective approach to the legal basis regulating the matters of civil liability of the CEO as one of the most important subject of a company is based on the importance of decisions and actions of this subject to the company’s business. Having disclosed the prevailing case law of the court of cassation that interprets the legal norms regulating civil liability of the company’s CEO and having discussed positive examples of the case law, the Supreme Court has summarised and provided answers to the aspects raising most questions in the case law – which are discussed in this article.

By Aušra Maliauskaitė-Embrektė, Associate Partner at law firm GLIMSTEDT; Laura Tunkevičiūtė, Junior Associate at law firm GLIMSTEDT.  

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Aušra Maliauskaitė-Embrektė

 

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Laura Tunkevičiūtė

 

Separation of civil liability of the Board and the CEO

When resolving the matted of separation of civil liability of the said management bodies and establishing existence of prerequisites of civil liability one must consider their competence set forth in the laws or other legal acts, or documents of the company and defining the limits of liability of the management body. The Supreme Court has noted that civil liability of different management bodies for the damages caused to the company must be separated and distributed since the obligations of each management body are independent, and performance of obligations by one management body does not exempt another management body from performance of his (9 January 2014 Supreme Court ruling in civil case No 3K-7-124/2014).

Where a claim is submitted for compensation of damages resulting from a transactions concluded by a company’s CEO yet approved by the Board of the company, liability for such transaction shall fall on the Board of the company in the absence of fault of the CEO. Should the CEO be also recognised at fault, the CEO and the Board shall be liable in accordance with the rules of partial liability considering the level of fault of each of them (9 January 2014 Supreme Court ruling in civil case No 3K-7-124/2014).

Civil liability of an actual CEO of the company

In practice, de jure CEO of a company is often not appointed or, where the latter is actually appointed, his functions are performed by another person. Therefore, it is recognised that in such cases the actual CEO of the company may also be held liable in civil procedure for non-performance or inadequate performance of obligations set forth in the law. Having recognised that a person not appointed as CEO of the company in the procedure set forth in the legal acts systematically performed functions usually performed by the CEO, such person shall be held liable for the damages incurred by the company as a result of his actions as a de jure CEO. In a situation where the company has an actual CEO in addition to a de jure CEO, the obligations set forth in the laws must be implemented by both CEOs.

The Supreme Court has noted that totality of circumstances where another person concludes employment agreements with employees, gives instructions on behalf of the company during maternity leave of the de jure CEO disregarding the fact that there has been no decision to appoint him as a temporary CEO leads to the conclusion of acquisition of the status of the actual CEO of the company (20 December 2013 Supreme Court ruling in civil case No 3K-3-697/2013).

When deciding on liability of de jure and actual CEO, the Supreme Court has stated that both CEOs who had violated their obligations to the company shall be liable for the damages caused as a result of conclusion by de jure CEO (who was on a maternity leave) of a transaction with the actual CEO on purchase of property owned by the company for the price lower than the market price. Throughout the period of time de jure CEO holds this position, she has fiduciary obligations to the company; thus, in this case de jure CEO unreasonably used the possibility to purchase property of the company. Hence, in the case under discussion civil liability for violation of the fiduciary obligations of the company CEO shall fall on the de jure as well as the actual CEO (29 May 2015 Supreme Court ruling in civil case No 3K-3-331-695/2015).

Influence of financial obligations of the company on the civil liability of the company’s CEO

Generally, civil liability of management bodies to a solvent company is direct; liability of management bodies of a company to the creditors of the company undergoing bankruptcy is subsidiary. The CEO is liable to the creditors as an additional debtor within the scope of obligations not implemented by the direct debtor, i.e. the company.

In a civil case, in which the creditor requested awarding unpaid remuneration for the contractor work performed to be paid by the company and (in subsidiary manner) by the company’s CEO, having established that already at the time of performance of the contractor work the CEO was aware of inability by the company to pay for the contractor work due to insolvency of the company, and having stated that the essential feature of subsidiary civil liability is that the subsidiary debtor is liable to the creditor in addition to the main debtor, the Supreme Court has stated that the court of the lower instance unreasonably considered the CEO as the main debtor and the company – as the additional one; as a result, it recognised the CEO as the additional debtor (20 November 2013 Supreme Court ruling in civil case No 3K-3-581/2013).

Possibility for the creditors to submit a direct claim against the company CEO

The Supreme Court recognised in its case law that a creditor may submit a direct claim against a company CEO. However, this is possible only if the latter had caused direct damages to the specific creditor rather than derivative damages to creditors as a group of interests as a result of inadequate management or failure to initiate bankruptcy case in due time. Thus, the right of the creditors to submit a direct claim is limited by the chosen grounds of the claim rather than the stage of bankruptcy procedure.

Prerequisites for civil liability of a company CEO

Civil liability of a company’s CEO is joint and several; therefore, all the prerequisites for application of civil liability must be established: (i) unlawful actions, (ii) damages, (iii) causal link between the unlawful actions and damages, and (iv) fault.

CEO’s actions shall be recognised as unlawful where imperative obligations, fiduciary obligations were violated or a decision was adopted in prejudice of the business judgment rule.

Imperative obligations set forth in the law must be implemented in the manner defined by the law. A company CEO may not choose a model of behaviour different from the one set forth in the law. Meanwhile, fiduciary obligations require compliance of behaviour with the standards of due care and loyalty.

When disclosing the fiduciary and imperative relation of the obligations of a CEO the Supreme Court has stated that civil liability of a company CEO is predetermined by violation of its obligations imperatively established under the law (obligation to address the court regarding initiation of a bankruptcy case in the event of insolvency of the company) as well as violation of fiduciary obligations to the company. thus, his civil liability is based on violation of special or fiduciary obligations rather than the circumstance alone that the company is unable to cover the debt to its creditors (25 March 2011 Supreme Court ruling in civil case No 3K-3-130/2011).

Performance and nature of fiduciary obligations depends on the financial situation of the company. Where a company functions normally and the CEO has no fiduciary obligations to the creditors the main obligation of the CEO during such periods is meeting the interests of providers of owned capital, i.e. the participants. The worse the financial state of the company gets, the greater importance of interests of the providers of lent capital of the company, i.e. the creditors, becomes. Therefore, as the financial state of the company gets worse, the CEO becomes subject to the fiduciary obligations to consider the interests of creditors too when adopting decisions related to the activities of the company. When the financial state of the company gets particularly complicated, the interests of creditors become prevailing (1 February 2012 Supreme Court ruling in civil case No 3K-3-19/2012).

Since the 2014, in order to harmonise the positive aspects of business risk and narrow down liability of a company CEO for business decisions which had failed the Supreme Court has expressis verbis started applying the business judgment rule in the cases related to civil liability of a company CEO. In accordance with the business judgment rule, it is presumed that the CEO acts within the interests of the company he manages. This presumption is intended to protect the company CEO from liability for the business decisions he had made in good faith and which meet the standards of the obligation of due care. The Supreme Court has noted that a CEO shall be held liable in civil procedure for adoption of a business decision in prejudice of the fiduciary obligations and/or while exceeding one’s power of attorney rather than for business failure. Therefore, it is insufficient for the person seeking compensation of damages to prove the fact of damages incurred; he must also prove violation of the fiduciary obligations (loyalty, good faith, reasonability, etc.) of the company CEO, obvious overstepping of the limits of reasonable economic commercial risk, obvious negligence, or exceeding of powers (9 January 2014 Supreme Court ruling in civil case No 3K-7-124/2014).

Another important obligation of a company CEO is handing over of the assets and documents of the company to the bankruptcy administrator upon coming into force of the court ruling regarding initiation of the bankruptcy case. It has been explained in the case law of the Supreme Court that only the last management bodies of the company have the obligation to hand documents and assets of the company over to the bankruptcy administrator. Persons who managed the company earlier may be liable for failure to hand over the documents on individual grounds if such persons inadequately organised accounting of the company and keeping of the accounting documents and accounting registers (3 July 2015 Supreme Court ruling in civil case No 3K-3-429-313/2015).

The obligation of the company CEO to manage the assets of the company with due care includes the obligation to maintain adequate accounting for the assets, submit the set of annual financial statements to the Register of Legal Entities, also keep the data on the operations of the company for the established period of time (3 July 2015 Supreme Court ruling in civil case No 3K-3-429-313/2015). Negligent management of accounting documents and incompliance with the actual situation demonstrates that the company CEO performed unlawful acts resulting in damages to the company (6 March 2015 Supreme Court ruling in civil case No 3K-3-131-687/2015). The Supreme Court has noted that inadequate accounting by itself does not result in damages because the assets although not being properly included in the accounting can be used in the activities of the company or retained. However, in all cases inadequate accounting complicates the possibilities to establish the composition and quantity of assets, lawfulness of their use, also causing alleged damages to the company where the assets have not been retained or used for purposes other than those of the company. Hence, the company’s CEO, who is responsible for sale or other use of goods, has failed to implement its obligation to properly organise accounting, make an inventory of the material assets, and by such omission created a situation where there is no data on movement of goods in the company, should not be exempt from the burden of proof and the latter should not be transferred to the company (20 May 2016 Supreme Court ruling in civil case No 3K-3-276-248/2016).

If the company not only incurred damages but also benefited as a result of unlawful actions of the CEO, the size of damages shall be calculated by deducting the benefits received from the mount of incurred loss. When speaking on damages caused because of delay by the CEO to initiate the bankruptcy case the Supreme Court has stated that from the moment the company became insolvent the CEO becomes bound by the obligation to initiate a bankruptcy case. Therefore, should the obligations of the company to its creditors increase from the said moment because of default by the CEO, such increase shall be considered as damages. Considering the merits of the institute of civil liability, liability of the company’s CEO is not a sanction for unlawful acts; in each case the damages are established in accordance with the factual circumstances of the case; therefore, in some cases the damages may be equal to the amount of claims approved in the bankruptcy case, and in other cases – a part of the claims of creditors which were not upheld in the case, or less than such part where it was established that not whole part of the outstanding debts was the result of failure by the responsible persons to request initiation of bankruptcy case in due time (27 October 2014 Supreme Court ruling in civil case No 3K-3-453/2014).

The Supreme Court recognises existence of the causal link as the prerequisite for civil liability of the company’s CEO because only the loss predetermined by the acts (actions, omission) of the company’s CEO is subject to compensation. The Supreme Court is of the opinion that when proving the causal link the claimant must prove that when adopting the disputed decision the defendant could have foreseen the future damages. The company’s CEO would be legally liable for non-performance of duties of the company’s CEO and would he held liable for the damages should it be proven that when concluding the transactions from which the claimant derives damages it was known in advance that they would result in damages to the company and yet, despite the said, the company’s CEO had nevertheless concluded such transactions (20 November 2013 Supreme Court ruling in civil case No 3K-3-581/2013).

When speaking of the last prerequisite of civil liability the Supreme Court has noted that fault is necessary for the CEO to be held liable in civil procedure. Should the court establish that the company’s CEO has performed unlawful acts resulting in damages, the fault of the latter shall be presumed (3 June 2016 Supreme Court ruling in civil case No 3K-3-298-701/2016). It has been established in the case law of the Supreme Court that the CEO shall be liable only if he is at fault rather than for violation of any obligations of his. Therefore, ordinary carelessness related to the risks of economic commercial activities of the company should not constitute grounds for civil liability of the CEO (20 December 2013 Supreme Court ruling in civil case No 3K-3-699/2013).

In cases, in which the matters of civil liability and fault of the CEO are resolved, application of the business judgment rule requires establishment of gross negligence or intent as a prerequisite. In order for the CEO to be held liable for failure to perform his obligations and damages caused it shall be proven that it was known in advance when concluding the transactions that they would result in damages to the company and yet, despite the said circumstances, the company’s CEO had nevertheless concluded such transactions, or the decision to conclude the transaction resulting in damages was adopted in a clearly negligent manner, where a reasonable and prudent CEO would not have concluded such transaction under identical conditions (29 May 2015 Supreme Court ruling in civil case No 3K-3-331-695/2015). Contrary to the case of harmful business decision or violation of fiduciary obligations, in the event of violation of the obligation under the law to initiate bankruptcy case in due time the CEO would be held liable in civil procedure if ordinary negligence was established (27 October 2014 Supreme Court ruling in civil case No 3K-3-453/2014).

Unbundling of civil and material liability of the CEO

The Supreme Court has indicated that the nature of legal status of the CEO is dual. Therefore, he is subject to liability of twofold nature: material liability under the labour law– limitation of liability of an employee within the scope and in the procedure set forth by the norms of labour law; meanwhile, civil liability is based on the principle of full compensation of damages (20 November 2009 Supreme Court ruling in civil case No 3K-7-444/2009). Should the company incur damages because of violation of the obligations established for an employee of the company such employee shall be held materially liable. The employee shall compensate for all the damages caused, however, such compensation shall not exceed an amount of his three average wages save for the cases where the employee must compensate for the full amount of damages. Where a CEO violated his fiduciary obligations or obligations set forth in relation to him as a CEO in special laws, civil liability shall apply.

The possibility of conclusion with the company’s CEO of an agreement on full material liability caused additional confusion in the case law. Considering dual nature of the relations between the company and its CEO, the circumstance that an agreement on full material liability of the CEO has been concluded with the latter, it in no way affects application of civil liability to the CEO. Norms of the Labour Code of the Republic of Lithuania (hereinafter the LC) do not regulate activities of the management bodies of the company. Therefore, one may not claim than norms of Chapter XVII “Material Liability” of the LC regulate liability of the company CEO as the management body of the company for non-performance or inadequate performance of obligations of the nature of civil law (20 November 2009 Supreme Court ruling in civil case No 3K-7-444/2009).


Teisininkai: Aušra Maliauskaitė-Embrektė, Laura Tunkevičiūtė

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